Craig Hodges
Craig Hodges is portfolio manager of the $396 million Hodges Fund (HDPMX) and co-portfolio manager of the $1.3 billion Hodges Small Cap Fund (HDPSX), Dallas. HodgesFund.com
Is there room for the stock market to go even higher this year? Mutual fund manager Craig Hodges says yes, and he adds that investors can still do well if they know where to find the stocks with the best potential.
Last year, he found enough opportunities to send his Hodges Pure Contrarian Fund soaring 70% for 2016 and his Hodges Fund jumping 40%. Much of that came after Election Day as President Donald Trump’s promises of economic stimulus, including tax cuts, deregulation and infrastructure spending, benefited many of the stocks in the funds that he manages.
This year, investors tempered their enthusiasm as they questioned whether Trump could deliver on his plans, especially after his effort to replace the Affordable Care Act (Obamacare) with a new health insurance law failed in March.
Hodges, however, still believes that Trump could get key legislation, such as an overhaul of corporate tax rates, through Congress.
Bottom Line Personal asked Hodges why he is confident that near-record stock prices can go even higher this year and which stocks are among his new favorites…
I believe that the change in the White House has unleashed the “animal spirits” of US business leaders, which is just a way of saying that there’s a renewed optimism in business and a greater willingness to invest.
This is a reaction to the potential for reductions in corporate taxes and government regulation. The tax changes could make it much less expensive for companies to bring home (“repatriate”) profits that they have been holding overseas, which would give them more money to spend on expansions and perhaps acquisitions. This would give the US economy a boost over the next few years.
Less regulation could be particularly good for small and midsize companies. That’s because larger companies such as those in the Standard & Poor’s 500 stock index have more people and resources that they can devote to regulatory compliance, and they benefit from economies of scale. In contrast, smaller firms end up spending more of their assets, on a relative basis, to comply with complex rules.
Smaller companies are often where I can find the best stock bargains, partly because fewer analysts are poring over their books and I have a better chance of finding something that has been overlooked.
I’m a contrarian investor, so I invest in companies that are recovering from a problem or that are, for a variety of reasons, undervalued. That tends to make them more volatile than the overall market. Here are five of my favorites now…
Encore Wire (WIRE). This is a maker of copper wire that is used in new homes and commercial construction. I’ve known of this company for probably 20 years and think it is well-managed. The CEO has worked his entire career at the company. Since 2007, when the housing market went into a slide, the company has cut costs and many of its competitors have gone out of business, so it is now positioned to be much more profitable.
Construction in the US has begun to recover, but it’s not yet near the last peak. If activity gets anywhere close to levels seen before the Great Recession of 2007–2009, Encore Wire might earn 50% more than during the previous boom. That would push the stock higher.
Forterra (FRTA). One thing you can look for that can make a company attractive is when its industry has what’s called a high barrier to entry—meaning that it would be hard for a new competitor to get in. Forterra qualifies in this regard. The company manufactures and distributes all kinds of pipe, from the iron conduit for drinking water to the concrete pipe for storm drains and sewer connections. It’s hard to ship large-diameter pipe more than 100 or 150 miles from where it’s made, so any potential new rival would need to establish a nationwide network of facilities similar to Forterra’s, which would be daunting.
Forterra could benefit from the increased infrastructure spending that President Trump has been promising, but the shares haven’t moved much yet. The company only just became public, completing an initial share sale in October, and its valuation is less than that of similar companies.
The real effect of an infrastructure-rebuilding program, if it got through Congress, still would be a year and a half away, so it’s not too late to buy the stocks that might benefit.
Hilltop Holdings (HTH). This company owns PlainsCapital Bank, a regional lender in Texas, and other businesses, including a securities brokerage and a small property-and-casualty insurer.
You want to own banks when interest rates are rising, as they will in this economy. They get more profit from the difference between the amount of interest they can charge for money that they lend and what they pay customers for money on deposit. Financial stocks have already moved much higher for this reason, and they’ve done especially well since Trump won because of the possibility that they will get some relief from the regulations that were enacted after the financial crisis.
We think investors don’t know what to make of a small financial company with so many parts—and that means there’s still potential for big gains as the leaders of the company address this issue.
Some of the nonbank operations could be sold, giving Hilltop cash to expand the bank or do something else to benefit shareholders while also tightening the focus of the company. Or the bank itself might be an acquisition candidate, which also could boost the stock prices.
Matador Resources (MTDR). This is a small energy exploration and production company that primarily drills in a region in West Texas and southeastern New Mexico called the Permian Basin, where oil is abundant and can be taken out of the ground relatively inexpensively.
You can evaluate a company like this by looking at the land that it owns and the price others are willing to pay for that land. Matador Resources owns more than 100,000 acres in one part of the Permian, called the Delaware Basin, where other companies have bought land to drill on for as much as $40,000 per acre.
Even if you use a more reasonable price of, say, $20,000 to $25,000 per acre, Matador would be worth more than $2 billion just for this part of its portfolio. Its market capitalization (the total value of its stock at the current price) has been right around $2 billion this year. The company owns fields in other attractive regions and a valuable crude oil–processing plant—assets that investors at the current price are basically getting for free.
This company works diligently to reduce costs, using knowledge gained from past wells to drill more quickly and efficiently. Matador’s wells in the Delaware Basin remained profitable even when oil prices plunged a few years ago.
Now oil has rebounded somewhat, trading around $50 a barrel since the middle of 2016, enough to produce hefty profits at Matador.
Mylan (MYL). You sometimes can find a company whose stock has been so beaten down because of a controversy that it has become a real bargain. Pharmaceutical maker Mylan is such a stock, hurt badly by the fiasco with its EpiPen epinephrine injector. The price of the product—a lifesaver needed by many families—had skyrocketed. The company received a lot of bad publicity for that—and rightly so. But Mylan is one of the biggest generic-drug companies, and the EpiPen is just one of its thousands of products.
The stock is cheap after pharmaceuticals as a group were hurt last year by presidential candidates complaining about drug prices. Mylan traded recently below $40, and the company is expected to earn more than $5 a share this year. So I think its valuation (based on its price-to-earnings ratio) is attractive. If the company earns what I think it will in 2018, the shares could climb as high as $60.
